Month: April 2016

Compliance Bricks and Mortar for April 29

I’m back from vacation and have a big stack of compliance-related stories to read. These are some of them.

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Why Haven’t Bankers Been Punished? Just Read These Insider SEC Emails by Jesse Eisinger in Pro Publica

James Kidney, a longtime SEC lawyer, was assigned to take the completed investigation and bring the case to trial. Right away, something seemed amiss. He thought that the staff had assembled enough evidence to support charging individuals. At the very least, he felt, the agency should continue to investigate more senior executives at Goldman and John Paulson & Co., the hedge fund run by John Paulson that made about a billion dollars from the Abacus deal. In his view, the SEC staff was more worried about the effect the case would have on Wall Street executives, a fear that deepened when he read an email from Reid Muoio, the head of the SEC’s team looking into complex mortgage securities. Muoio, who had worked at the agency for years, told colleagues that he had seen the “devasting [sic] impact our little ol’ civil actions reap on real people more often than I care to remember. It is the least favorite part of the job. Most of our civil defendants are good people who have done one bad thing.” This attitude agitated Kidney, and he felt that it held his agency back from pursuing the people who made the decisions that led to the financial collapse. [More…]

Yes, But WHY Are There So Many Fewer Publicly Traded Companies? by Kevin LaCroix in the D&O Diary

This often-overlooked observation is important, but it doesn’t address the more fundamental question of why there are so many fewer publicly traded companies than there once were. A recent academic paper documents the decline in the number of publicly traded companies and suggests several possible reasons for the decline. I have my own thoughts, as well. As discussed further below, these decline in the number of listed companies has important implications for the economy generally and for the D&O insurance marketplace in particular. [More…]

Private Offerings and Public Ends: Reconsidering the Regime for Classification of Investors Under the Securities Act of 1933 by Jonathan D. Glater in the CLS Blue Sky Blog

There are different ways to limit how much risk an investor takes on. One is to impose a fiduciary duty on a fund manager, for example, requiring that the level of risk be consistent with the goals of the future retiree. My article addresses another method: Restricting investment in securities more likely to be high-risk and, consequently, less certain to produce the return needed to achieve the goal of financially secure retirement. [More…]

Adviser official to pay $650K for soft-dollar manipulation, misuse by Amy Leisinger, J.D. in Jim Hamilton’s World of Securities Regulation

When the soft-dollar balance fell too low to pay the fake invoices, the court stated, the individuals churned the stocks in the funds’ brokerage accounts to generate more, increasing the trade commissions paid by the funds. When they knew the funds would need to close due to poor performance, they continued to trade in the accounts to eliminate the deficit in the soft-dollar balance that Archer would have had to pay when it closed the soft-dollar accounts. The excessive trading was inconsistent with the funds’ stated investment strategy, the court noted. [More…]

SEC warns of third party cybersecurity risks by Elizabeth Wu in PFM

Before using a third party vendor, firms should conduct significant amounts of due diligence on the vendor, warned Steven Levine, associate regional director, National Exam Program, Chicago Regional Office at the SEC at a compliance outreach event.
RT Jones is an example of the risks. The firm, a provider of investment advice for retirement plan participants, was a victim of a cyber-attack. The firm used a third-party hosted server containing client information for four years and failed to report it to the SEC, for which it was fined $75,000 in September 2015. [More…]

SEC’s Ceresney says more cybersecurity cases ‘coming down the pike’ by Bruce Carton in Compliance Week

The SEC has begun to bring cybersecurity-related enforcement actions under Regulation S-P of the Securities Act of 1933, and Enforcement Director Andrew Ceresney stated this week that more such cases are now “coming down the pike.” [More…]

The Only Game In Town

I’m getting caught up on reading while on April vacation. I just finished The Only Game in Town by Mohamed A. El-Erian.

the only game in town

The book is an exploration of central banks in the economy. The brilliant Mr. El-Erian sees a coming crisis. One that can be avoided, but we must take action to avoid it.

He lauds the Federal Reserve and The European Central Bank for taking decisive steps to stop the financial crisis of 2008. The central banks created liquidity and propped up the financial system and financial institutions. The central banks continued their work to heal the economies as countries entered the Great Recession and slowly crawled back out.

Mr. El-Erian points out that central banks have a very limited set of tools. Its up to the political leaders to use their broader set of tools to create and implement programs that will fix the lagging economies. If not, the crisis will come.

The Federal Reserve is keeping the key interest rates low to stimulate the economy. That is resulting in asset bubbles as investors and companies pile on cheap debt. It is hurting long term investors who are far to one side on the risk curve looking for safe returns.

With its limited set of tools, the Federal Reserve is not able to create inclusive growth. It’s not able to invest in infrastructure and education. It’s up to the political system. The political system is failing us. Congress went 5 years without passing a budget, one of its core duties.

The Only Game in Town is both hopeful and pessimistic at the same time. Its well worth your time to pick up a copy and read.

A Chairlift to Securities Fraud

The Securities and Exchange Commission brought charges against the owners of Jay Peak resort in Vermont’s Northeast Kingdom just as ski and snowboard season is winding down. The Miami-based ownership was allegedly using fraudulent EB-5 offerings to raise money and take a bit off off the top for themselves.

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Jay Peak is wonderful mountain for snowsports, but you need to spend quite a lot of extra time getting there. Historically, there was not much at the mountain except for the mountain. Lately, the resort has added a hotel and an indoor water park. According to the SEC, the owners were involved in some shenanigans when raising money for these improvements.

The EB-5 Visa program allows an immigrant and family to live or work or retire in the United States. It requires investment in an enterprise that creates jobs for US citizens. The minimum amount of money to invest is $500,000 for an investment in a rural or high unemployment area. The EB-5 immigrant investor visa program is intended to attract foreign capital into the US and create jobs for American workers.

The Jay Peak program, combined with a similar strategy at nearby Burke Mountain and a biotech research building, was one of the biggest projects to be financed in this way.

According to the SEC complaint, the problem started with the purchase of the ski mountain. The head of the company, Ariel Quiros commingled funds from two separate investment programs to help fund the acquisition. Inexplicably, investor money was deposited in a brokerage account and Mr. Quiros arranged for margin loans and cross-collateralized the accounts across investment programs.

The final straw appears to be the biotech building. The offering documents misrepresented that there was FDA approval in place. The SEC also alleges that Quiros pocketed some of the investor money.

The SEC complaint is full of charges of mismanagement, theft and fraud.

I fear that the result will be a terrible blow to Jay Peak. I assume that half-completed projects will sit decaying in the ground for years, if not decades. The resort itself will not have the capital to operate well.

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Compliance Bricks and Mortar for April 15

These are some of the compliance-related stories that recently caught my attention.

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Am I a Good Compliance Officer? by Kristy Grant-Hart in SCCEs Compliance & Ethics Blog

I thought for a long time about a single criterion which could determine whether a person was good or bad at the job. I finally decided that the best way to determine whether a person is a good compliance officer is whether, over time, the business proactively comes to the compliance officer with problems or to ask for advice. The most successful compliance officers are those who gain the trust of the business and who become integral to its operations. [More…]

The Morning Risk Report: Report Details ‘Right Way’ to Teach Ethics

The research involved showing the survey subjects a conflict of interest presented in four different ways: just presenting it and asking them what they thought; providing them a dictionary definition of what a conflict of interest is; giving them one example of a conflict and, finally, giving them two examples and asking them to compare them, said Mr. Loewenstein. In the first three instances, about 10% to 15% of the subjects were able to identify the conflict, whereas in the final instance the numbers jump to between 30% and 50%, he said. [More…]

What Goes on a Compliance Dashboard? by Matt Kelly in Radical Compliance

The starting point should be to ask, what worries compliance officers and general counsels the most? That is easy enough to answer at a high level: you worry that risks the company has are metastasizing beyond your comfort zone. A dashboard should show you which risks may be doing that at any given time. [More…]

The SEC’s Shift to Administrative Proceedings: An Empirical Assessment by Stephen J. Choi and Adam C. Pritchard in the CLS Blue Sky Blog

We show that the shift toward administrative proceedings has been accompanied by a substantial increase in the average civil penalty imposed on non-financial public companies named as defendants, both in court and in administrative proceedings. We also provide evidence that the complexity, and thus the cost, of cases the SEC brings in administrative proceedings increased after the enactment of Dodd Frank. Specifically, we show an increase in two proxies for the complexity of the nature of the alleged underlying securities law violation, the disgorgement amount, a measure of the underlying profits from the alleged securities law violation, and the number of years during which the violation allegedly took place. Violations that involve greater profits are likely to be longer running and involve more transactions and participants. [More…]

Managing Gatekeeper Anxiety by Michael W. Peregrine in the D&O Diary

Corporate board members are encountering a new, perhaps unexpected and likely distracting oversight responsibility: managing the personal liability concerns of corporate “gatekeepers”. This new responsibility is the byproduct of three particular, intersecting developments: the Department of Justice enforcement focus on individual accountability; regulatory scrutiny of the role of corporate “gatekeepers” in connection with financial reporting and corporate compliance; and ongoing litigation addressing access to traditional individual defenses. The corporate board will want to pursue pro-active responses to these concerns in order to assure the continued engagement of its valued “gatekeepers”. [More…]

 

Love For Your Mother Can Be Insider Trading

Lawrencia Afriyie took some risky bets in the market. She bought out-of-the-money options, but made $1.5 million in profits. It just so happens that her son, John, worked for for an investment firm that had material non-public information on the target of those options.

Cash in the grass.

According to the SEC complaint, John Afriyie worked at an investment firm involved in a going private deal for ADT. He accessed documents that were designated “confidential” or several variations of confidential. He must have seen a golden opportunity to make some money on the side.

Since Mr. Afriyie had signed the investment firm’s Code of Business Ethics that prohibits trading on material, non-public information, he could not trade on the information.

Mysteriously, his mother, Lawrencia, bought 2,279 options on ADT from January 28 through February 12. The options were out of the money, with strike prices between $32 and $34 a share, while the stock was trading between $24 and $28. She was most of the trading activity on these options on many days during that period.

On February 16, ADT announced its acquisition at a price of $42. Lawrencia made a profit of $1.5 million on $24,000 in options.

Based on the trading activity in Lawrencia’s account, I would assume the compliance officers on her account saw a big red flag: extremely well timed option trades just prior to a major announcement. The complaint does not say so, but I assume that this option trading was unusual for her account.

Then it was up to the regulators to tie her to the source of information. Did she rat out her son and tell the regulators that it was him trading on her account? Her son had just made her a big pile of cash.

Probably not. FINRA would have seen the suspicious name to the firms involved in the transaction. Someone at the investment firm would have matched the last names and asked John what his mother’s name was.  Then compliance would have looked closer, reported the problem and booted him out the door in short order.

Now the SEC has brought charges to recover the gains and the DOJ has brought criminal charges.

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Racing, Compliance and Cheating

With the Boston Marathon on Monday, the legend of Rosie Ruiz comes up as one of the most infamous sports cheats. Races have since added controls, but cheaters still look for ways around the controls.

Rosie Ruiz, center, is helped by Boston police after winning the women's division of the Boston Marathon, April 21, 1980. Ms. Ruiz had a partial unofficial time of 2 hours, 31 minutes, and may have broken the women's record set in 1979. (AP Photo)

For those of you not familiar with the history of the Boston Marathon, Rosie Ruiz was declared the winner of the 1980 Boston Marathon with a time of 2:31:56. At that time, it was one of the fastest female marathon runs. Currently, the female elite runners leave before the men. In 1980, women were back in the pack and harder to track.

Now, racers have a timing chip that notes when the athlete passes certain points in the course. It makes it harder to cheat because you need to figure a way to get the chip to each of those points.

According to a recent article in the New York Times on an ironman athlete, the athlete tried to circumvent the system by claiming that her timing chip fell off. The general rule for most races is that if you don’t finish with your timing chip, you don’t get a finishing time. She plead for reinstatement, and had her time reinstated. That also made her the winner of her division.

In looking at running portion of the race course, it seems clear that the course failed in having enough timing checkpoints. The course consisted of two laps, with several points that a cheater could cut across the route.

The other element helping to catch cheaters is the prevalence of spectators that can provide meaningful race data. We all have mini-computers in our pockets with phones that accurately capture time and location. Race officials were able to identify the time and place of the athlete on certain parts of the course that did not match her claimed performance based on spectator images.

Officials should not have had to rely on extrinsic data. There should have been more timing mats. Race officials should not have allowed reinstatement of her time. They should particularly not allowed reinstatement when it gave the athlete a win in her division.

Controls are in place to prevent cheating, allowing circumvention of the controls is a compliance failure by the race officials. It takes well-deserved recognition from the athletes who followed the rules.

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Chaos in Commissioner Confirmation

I thought the picks for Securities and Exchange Commissioner would fly through the confirmation process. I was clearly wrong and Congress is even more dysfunctional than I thought.

fairfax and peirce

The SEC is now down to just three members after two left the agency late last year. President Obama nominated Lisa Fairfax, a Democrat, and Hester Peirce, a Republican, to fill the vacancies. Each side of the political divide would likely find one acceptable and accept the other as part of a package.

The discussion about the nominees was held in executive session so we don’t know exactly what was said.

Many groups have urged the SEC to adopt a rule requiring public companies to disclose political donations to nonprofit groups that can spend unlimited amounts of money on political advocacy and advertising. Direct corporate contributions to candidates and party committees already are disclosed. Personally, I don’t see how that affects the SEC missions to protect consumers and have healthy capital markets. The argument is that shareholders should know which political candidates or causes are receiving their money.

Four Senators are holding up the nomination based on this issue. Charles Schumer of New York and Robert Menendez of New Jersey, said they would oppose the SEC picks. They are joined by Elizabeth Warren of Massachusetts and Jeff Merkley of Oregon.

The four Senators feel that the nominees don’t have sufficient belief in further regulating campaign spending by public companies. It will be curious how this should be handled since the 2016 spending bill explicitly denied the SEC the funds to issue or implement this rule.

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Taking Management Fees In Advance, and Then More

It is not uncommon for fund managers and investment advisers to take management fees payable in advance. At some point, taking fees in advance is just stealing from investors. Steven Burrill and his firm reached that point and went well beyond it.

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To be clear, taking management fees in advance is not illegal. In fact, the SEC filings for registered investment advisers specifically contemplate it. For those of you who recently filed your Form ADV, Item 18 in Part 2A addresses additional disclosures that must be made if you take prepayment of more than $1200 in fees per client six months or more in advance.

Burrill Capital Management was an exempt reporting adviser with the SEC under the Investment Advisers Act. The firm fell into the venture capital firm exemption.

For fund managers, the ability to take a management fee and whether it can be taken in advance is going to be governed by the fund documents. In the case of Burrill Life Sciences Capital Fund III, LP, it appears the fund documents allowed the manager to take the management fee at the beginning of a quarter for the services to be given during that quarter.

Burrill ran into cash flow issues and took cash from the fund as an “advance on management fees” in late 2007 for the first quarter of 2008. It was violation of the fund documents. It was only four days early, but still a clear violation. It was only a small step, but it was a step over the line.

That made it easier for Burrill to take more steps over the line. Burrill continued to take management fees earlier than allowed by the fund documents when the firm encountered cash flow issues.

Since Steven Burrill owned most of the firm, a big chunk of that management fee would end up in his personal accounts. But to make the early advances even worse, Burrill at times directed the early advances to be deposited directly into his personal bank accounts.

By the first quarter of 2012, the firm had taken more in advanced management fees than could be expected to be earned over the life of the fund. But Burrill still kept taking cash from the fund.

Although this comes across as an SEC enforcement case, private action had happened much earlier.

Ann Hanham, Roger Wyse and Bryant Fong,  former employees of Burrill, discovered the problem in 2013. The trio confronted Burrill. After no action was made to repay the fund, the trio went to investors in the fund. The investors removed Burrill as general partner of the fund in 2014. The investors filed a fraud suit against Burrill in 2015. The investors also filed a suit against the fund’s auditor for failing to catch the fraud.

The SEC case resulted in Burrill repaying $4.785 million he took for personal use and a $1 million penalty.

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Compliance Bricks and Mortar for April 1

These are some of the compliance related stories that recently caught my attention.

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Valeant may get bank waivers but risks default with SEC and NYSE by Francine McKenna in MarketWatch

Valeant Pharmaceuticals International Inc. may get a waiver from its bank lenders to file its Form 10-K annual report and first-quarter report later than required. But that doesn’t solve the problem of who will sign off on those reports and whether they will be ready in time to meet its reporting obligations to the Securities and Exchange Commission and the New York Stock Exchange. [More…]

Why Compliance Matters: Credit Suisse Edition by Matt Kelly in Radical Compliance

The real news for compliance professionals—or anyone else working in finance who wonders why compliance is supposedly so important—is the outburst Credit Suisse’s new CEO Tidjane Thiam delivered while disclosing those 2,000 job cuts. The cuts, plus a $346 million write-down in business the bank took this quarter, were required because of sloppy risk management and compliance. [More…]

LONDON ‘KLEPTOCRACY TOUR’ FEATURES OLIGARCHS’ MANSIONS (WITH VIDEO) by Richard L. Cassin in the FCPA Blog

How do the wealthiest citizens of post-Soviet countries keep their money safe? For some, it’s simple: just buy a palatial home in London. To show the public how it’s done, anti-corruption campaigners took journalists on a “Kleptocracy Tour” of London, showing them residences owned by foreign oligarchs. [More…]

Court Won’t Hear Dispute Over Constitutionality of SEC’s Administrative Law Judges by Rodney F. Tonkovic, J.D. in Jim Hamilton’s World of Securities Regulation

The Supreme Court has denied certiorari in three securities-related cases. The court declined to hear Laurie Bebo’s argument that the Seventh Circuit misapplied the high court’s jurisdictional test in ruling she could not challenge the constitutionality of the SEC’s administrative law judges in a federal district court. The second petition denied today was brought by an adviser seeking review of an SEC administrative law judge’s finding of liability for market manipulation. The Court also let stand a Fifth Circuit decision finding that the extender provision of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) preempted the statute of repose in the Texas Securities Act. [More…]

Can Securities Regulation Solve Social Problems? by Hans Christensen, Eric Floyd, Lisa Liu and Mark Maffett in the CLS Blue Sky Blog

Regulators seem to think so. In the Dodd-Frank Act, policymakers made an unprecedented move towards using securities regulation to address issues unrelated to the Securities and Exchange Commission’s (“SEC”) core mission of protecting investors and maintaining the fair and efficient functioning of financial markets. The Dodd-Frank Act requires financial statement dissemination of information regarding purchases of war minerals from Congo and mine health and safety performance. The objectives of these policies are noble—more than ten million people have died in Africa’s Great War and every year hundreds of workers are injured or killed in U.S. mines. Yet, can such regulation affect wars or improve mine safety? Research by Hans B. Christensen, Mark Maffett, and Lisa Liu from the University of Chicago and Eric Floyd from Rice University suggests it can. [More…]

RECOGNIZE A LOW TRUST ORGANIZATION, AND REAP THE REWARDS OF A HIGH TRUST CULTURE by Barbara Kimmel in the FCPA Blog

Not just Barclays but many organizations find themselves in trust traps because they hold on to the notion that trust and ethics are “soft skills.” So over time, trust and ethics in their organizations are overlooked or taken for granted, and eventually decline.

In fact, that’s the pattern of decline we can see across all major institutions, public and private, in every industry and segment.

To avoid falling into that pattern, leaders need to recognize the warning signs of a decline in low trust and ethics. Only by seeing the problem can they bring a solution. [More…]